Should You Consider Equity Savings Fund As A Savings’ Option?
May 24, 2019

Author: Divya Grover

(Image source: Image by Mona Tootoonchinia from Pixabay)

Exposure to equity is something that prevents some investors from looking at mutual funds as an investment option due to the risk factor. This prompted mutual fund houses to promote conservative hybrid funds (erstwhile monthly income plan) for investors looking to park their savings in mutual funds without the risk of high equity exposure.

As per SEBI mandates, conservative hybrid funds can allocate 75-90% of the total assets in debt instruments, while 10-25% of the total assets can be invested in equity and equity-related instruments. Investors found this aspect appealing because they could invest in a mutual fund scheme that has low volatility and receive regular income in the form of interest. Additionally, they would be able to earn slightly higher returns than pure debt schemes, thanks to the equity component (due to dividends and capital appreciation).

However, in 2014-15, the government extended the holding period required for non-equity schemes to be classified as short-term capital gain from 12 months to 36 months. Short-term capital gains are taxed as per the income tax applicable to an investor, while long-term capital gains are taxed at 20% with indexation benefits.

That meant investors would have to wait for three years to get indexation benefits. This new change made the scheme unattractive, especially to investors in the highest tax slab.

To retain investors and address their concern, mutual fund houses came up with a new product called Equity savings fund - a scheme which invests in equity, arbitrage, and debt. According to SEBI, equity savings fund can invest a minimum of 65% of total assets in equity and equity-related instruments and a minimum of 10% of the total assets in debt.

The factor which differentiates equity savings fund from a pure equity fund is that equity savings fund makes use of derivatives (arbitrage opportunity) to manage the volatility that it is exposed to because of the high equity component.

[Read: Equity Savings Fund Vs Regular Savings Fund, Which Is A Better Option For You?]

The arbitrage strategy aims to take advantage of the price differential in the cash and future market by buying the securities in the cash market and selling it in the futures market. While SEBI has not mandated the percentage of equity portion that can be hedged (arbitraged), most funds keep hedged portion of up to 60-75%, while the rest is kept unhedged.

The arbitrage opportunity reduces the impact of volatility as it takes advantage of the price differential, sans speculation. The minimum hedged and unhedged exposure should be stated in the scheme information document (SID).

The mix of equity, arbitrage, and debt hence creates a balanced portfolio by reducing the overall volatility of the equity component. As result of this lower risk, investors will not be eligible for the benefits that one would get by investing long term in a pure equity scheme.

If the debt instruments generate better returns than the equity instruments, the fund may reduce its hedged and unhedged equity exposure. Such asset allocation under defensive considerations may be stated in the offer document.

In terms of risk profile, equity savings scheme can be positioned below aggressive hybrid and balanced hybrid schemes. As compared to debt funds and arbitrage funds, it exposes the investor to higher risk. However in this case, the risk is significantly reduced when compared to pure equity funds.

[Read: Should You Depend On A Debt Fund To Clock High Return Than Bank FDs?]

The hedged equity portion reduces the overall volatility of the scheme, while the unhedged portion can bring in capital appreciation. Arbitrage opportunities are higher in a bull market and lesser during the bear phase. At such times, the debt component will provide a safety net and may also provide regular income in the form of interest.

As equity saving schemes invest at least 65% of the assets in equity instruments, their tax implication is similar to equity funds. Equity savings fund will attract short-term capital gain of 15% if redeemed within one year. Long-term capital gain is taxed at 10% for gains above Rs 1 lakh in a year and no tax if the gains are below Rs 1 lakh.

[Read: Key Reasons To Start Tax Planning Early This Financial Year]

Equity savings schemes were launched only after 2014-15, making them relatively new with no performance track record over a longer time frame. When analysed for 1-year time frame, most of the schemes gave returns lower than the benchmark, while for 3-year time frame, the returns were in line with or better than the benchmark. For the 5-year time frame only two schemes out-performed the benchmark index. Therefore, it can be ideal if you want to park your savings for up to 3 years.

Table: Performance of Equity savings fund

Scheme Name CAGR (%)
1-year 3-year 5-year
Aditya Birla SL Equity Savings Fund(G)-Direct Plan 4.0711 9.3262
Axis Equity Saver Fund(G)-Direct Plan 9.2593 10.4911
DHFL Pramerica Equity Savings Fund(G)-Direct Plan 8.0806 8.6907 9.9393
DSP Equity Savings Fund(G)-Direct Plan 4.9115 9.2424
Edelweiss Equity Savings Fund(G)-Direct Plan 7.1902 9.3696
HDFC Equity Savings Fund(G)-Direct Plan 7.6487 13.1625 9.5671
ICICI Pru Equity Savings Fund(G)-Direct Plan 8.3837 10.1069
IDBI Equity Savings Fund(G)-Direct Plan 4.9808 5.4804 6.7369
IDFC Equity Savings Fund(G)-Direct Plan 5.547 6.1108 6.6992
Kotak Equity Savings Fund(G)-Direct Plan 7.3334 9.4834
L&T Equity Savings Fund(G)-Direct Plan 4.1347 7.954 8.386
Mahindra Dhan Sanchay Equity Savings Yojana(G)-Direct Plan 7.4593
Principal Equity Savings Fund(G)-Direct Plan 5.4413 8.4579 7.8785
Reliance Equity Savings Fund(G)-Direct Plan 1.7258 8.4476
SBI Equity Savings Fund(G)-Direct Plan 5.5141 8.7196
Tata Equity Savings Fund(G)-Direct Plan 6.3084 7.7932 7.6102
CRISIL Short Term Debt Hybrid 75+25 Fund Index 9.0911 9.6467 9.2172
(Source: ACE MF)
(Returns less than 1 year - Absolute, greater than 1 year - Compounded annualised)

You should invest in equity saving schemes if-

  1. You are a conservative investor looking to earn higher returns by taking low risk

  2. You are looking to park your money for the short-term

  3. You are looking for a tax-efficient mutual fund product without investing in pure equity scheme

  4. You want to invest in a balanced scheme with low volatility

The aim of the scheme is to provide a balanced mix of assets with lower volatility and tax-efficiency. Investors should select the fund only after checking its role and suitability to fulfil their financial goals.

You also need to determine where it will stand in the overall asset allocation of your portfolio. If you are seeking capital appreciation for the long term, then this scheme may not be right for you. If you are unsure, ask your investment adviser about the scheme's suitability for your portfolio.

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